Chile is poised to start the easing cycle this week. Rate cuts along with the rally in copper should help the economy rebound this year. However, Chile is facing some political risks as the November presidential election approaches.
The ruling center-left coalition Nueva Mayoria’s losses in the October municipal elections does not bode well for its prospects in the presidential election this November. President Bachelet’s popularity during her second term has been hurt by several corruption scandals, the weak economy, and a poorly executed structural reform agenda.
Former President Sebastian Pinera of the opposition center-right coalition Chile Vamos may be considered the frontrunner for the November 2017 vote. However, polls do not show Pinera to be particularly popular (around 20% support), as he has been dogged by corruption allegations too. Indeed, voter apathy may be the biggest determinant of this year’s vote. Turnout for last October’s municipal vote was a paltry 35%, the lowest for any election since the return to democracy in 1990.
Socialist Party leader (and daughter of former President Salvador Allende) Isabel Allende withdrew her candidacy for the presidency back in November. She instead threw her support behind center-left candidate Ricardo Lagos, another former president. The center-right may be considered to be more business-friendly than the center-left. However, the policy differences in practice are quite small.
Recycling past presidents is really not a good strategy during a time when “establishment” candidates are doing poorly worldwide. One needs only to look at Jorge Sharp’s victory in October as mayor of second-largest city Valparaiso for confirmation. He ran as an outsider and was supported by a strong grassroots movement. Similarly, Senator Alejandro Guillier is running as an anti-establishment candidate for this November, and is polling around 15% support. A victory by someone outside of the center-left and center-right establishment would introduce great uncertainty into policies going forward, and so Guillier bears watching.
The economy is still sluggish. GDP growth is forecast to accelerate modestly to around 2% in 2017 from 1.7% in 2016. GDP rose 1.6% y/y in both Q2 and Q3. However, monthly data so far show a 0.9% y/y rate for Q4 and so there are downside risks near-term. On the other hand, higher copper prices should help boost growth in 2017.
Copper prices bottomed last year. In October, Chilean Copper Commission (Cochilco) forecast copper prices averaging $2.20 per pound in 2017 year vs. $2.15 in 2016. We see upside risks, as Trump’s victory along with signs that the mainland Chinese economy stabilized helped boost prices over 25% since the start of November. However, the rally has stalled out in recent weeks.
Price pressures are falling, with CPI decelerating to 2.7% y/y in December. This is the lowest rate since November 2013, and has been in the 2-4% target range for five straight months. This supports the case for a 25 bp rate cut when the bank meets Thursday. The central bank last hiked rates 25 bp to 3.5% in December 2015 but has been on hold since.
Fiscal policy has remained prudent. Unlike many of the commodity exporters, Chile was relatively well-prepared for the downside of the commodity cycle. A structural fiscal rule introduced in 2001 has kept spending under control, and so its debt stock remains one of the lowest in the region despite the economic slump. The budget deficit came in at an estimated -3% of GDP in 2016, little changed from 2015. It is expected to remain steady in 2017.
The external accounts bear watching. Lower copper prices have hurt exports, but low energy prices and the sluggish economy have helped reduce imports. The current account gap was about -2% of GDP in both 2015 and 2016, and is expected to remain steady in 2017. Foreign reserves have remained fairly steady and at $40.5 bln in December, they cover nearly 7 months of import and are almost 3 times larger than short-term external debt.
The peso has done better after a poor 2015. In 2015, CLP lost -14% vs. USD. This was within reach of the worst performers ARS (-35%), BRL (-33%), ZAR (-25%), COP (-25%), and RUB (-20%). In 2016, CLP rose 5.5% vs. USD and was behind only BRL (+22%), RUB (+20%), ZAR (+12.5%), and COP (+6%). So far in 2017, CLP is up nearly 2% YTD and is in the middle of the EM pack. Our EM FX model shows the peso to have NEUTRAL fundamentals, so this year’s “so so” performance is to be expected.
Chilean equities have also done better after a poor 2015. In 2015, MSCI Chile was -19% while MSCI EM was -17%. In 2016, MSCI Chile was up 14% vs. 7% for MSCI EM. So far this year, MSCI Chile is up 3.7% YTD and compares to 4.6% YTD for MSCI EM. This slight underperformance should ebb a bit, as our EM Equity model has Chile at a NEUTRAL position.
Chilean bonds have outperformed recently. The yield on 10-year local currency government bonds is about -20 bp YTD. This compares to the best performers Indonesia (-42 bp), the Philippines (-37 bp), and Brazil (36 bp). With inflation likely to continue falling and the central bank likely to cut rates several times this year, we think Chilean bonds will continue outperforming.
Our own sovereign ratings model shows Chile’s implied rating at A-/A3/A-. The fall in copper prices has taken a toll on the nation, and we believe actual ratings of AA-/Aa3/A+ are facing some downgrade risks.